Smart Approach and Really Stupid Ones in Paying Off Debt

Wednesday, April 29th, 2009 at 6:28 pm

payingoff-debt The smart ways get us back on track quickly, minimize the total amount of interest we pay and allow us to meet our important financial goals.The stupid ways have us scrambling for easy solutions that don’t fix the real problem, cost us more in the long run and trash our credit rating. The household that carries a $6,000 credit card balance at 17% pays about $964 in non-tax-deductible interest each year. Most of us, if we thought about it, would probably rather have that money in our pockets than send it to a credit card company.

You could be even further ahead if you invested the money. If you didn’t have the card debt and you invested $964 each year, you could produce a nest egg of more than $426,000 in 40 years if you earn 10% annually.

With that to motivate you, here’s an assessment of the best and worst ways to tackle your debt:

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* Smart way. Stop spending! Or at least retire the credit cards for a while. You can’t work your way out of a hole if you keep digging.

Some people lock their cards in their safe deposit box; others freeze them in a block of ice (although that ruins the little magnetic strip on the back). Pay cash for purchases until your debts are paid.

* Stupid way. Transfer your balance to a credit card with a 3.9% teaser rate, and then keep charging to take advantage of that great low rate. First of all, the rate for buying stuff may not be the same as the rate for balance transfers; many cards have different, higher rates for new purchases. Even if the rates are the same, the teaser rate is going to expire eventually, leaving you with a bigger debt at a higher rate.

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* Smart way. Find a card with a low “fixed” rate (one that isn’t scheduled to expire in three to six months) and transfer your other card balances to that card. The credit experts at Good Advice Press (http://www.goodadvicepress.com) agree that this is one of the cheapest and best ways to pay off debt. You can find offers for low-rate cards at Bankrate.com (http://www.bankrate.com),CardWeb (http://www.cardweb.com)and here.

* Stupid way. Move your balance from card to card every few months, chasing low teaser rates. Sooner or later you’ll get caught by a rate that jumps before you expect it or a hidden transfer fee that boosts your balance.
Opening lots of credit card accounts also is a good way to trash your credit rating; lenders are suspicious of people who open many accounts in a short period.

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* Smart way. Pay off your highest-rate, nondeductible debt first, then apply the same size payment to your next-highest-rate, nondeductible debt, until all your nondeductible debts are paid off.

Say you have $200 a month to put toward paying off your debts. You have $2,000 on a department store credit card with a 17% rate and $3,000 on a bank card with a 9.9% rate. If you split the payment between the two cards, it will take you nearly three years and cost you $829 in interest before you are debt-free.

But if you pay only the minimum on the lower-rate debt and apply the rest of the $200 toward the higher-rate debt, you will pay off the entire debt six months faster and save about $80 in interest. Boost your payment by just $50 a month, to $250, and you can pay off the debt in less than two years and save $254 in interest.

The debt-reduction calculators at Web sites such as Quicken’s at http://www.quicken.com can show you how this works for your own debt,and this one here

* Stupid way. Make extra payments on your tax-deductible mortgage or home equity loan while carrying high-rate credit card debt.

There’s nothing wrong with wanting to pay your mortgage off a little early with extra payments toward the principal–unless you’re doing so while carrying much more expensive debt. Also, most people would be better off putting any extra money into their 401(k) retirement accounts or funding a Roth IRA before paying off a 7% or 8% mortgage.

* Smart way. If you are deep in credit card debt and your repayment plan will take five years or longer, consider a home equity loan (assuming you have some equity) to consolidate your card debt and (usually) make the interest tax-deductible–but only if you cut up your credit cards and are committed to not running up debt again.

Home equity loans are a fast way to financial oblivion for people who can’t control their spending; you’re putting your home at risk should you be unable to repay the loan, and you’re also eating up equity that you might need later in a financial emergency.

Home equity loans also are a bad idea for people who could pay off their debts in a few years, because such loans stretch out the debt for 10 years or longer and can ultimately increase your interest costs–even after taxes.

* Stupid way. Tap your retirement funds to pay off credit card debt. Borrowing from your 401(k) means that money is no longer earning tax-deferred returns for you. And you wind up paying taxes twice on the money you use to repay the 401(k) loan–once when you earn it, and again when you take it out in retirement.

Taking money out of an individual retirement account is even worse; you lose the tax deferral for good, and you also face income taxes and penalties that can eat up more than half of what you withdraw.

* Smart way. If you’re really in over your head–if you have to borrow from one credit card to pay another, if you can’t make your minimum payments or if debt is ruining your life–you can turn to a nonprofit credit counseling firm such as a Consumer Credit Counseling Service. For more information about consumer credit counseling, visit http://www.nfcc.org,and Free National Credit Report

Consumer Credit Counseling service can negotiate with your creditors for lower interest payments and better repayment terms. Such a debt management plan will show up on your credit report and can make it difficult for you to get new credit for a while–but that’s probably a good thing if you’re already in trouble.

* Stupid way. Turn to a high-interest debt consolidation loan or a for-profit, fly-by-night company that calls itself a credit counseling firm but that really makes its money by charging you excessive fees.

Tags: card balances, credit card balance, deductible interest, Home equity loans, minimum payments, safe deposit box

Debt Reduction

Saturday, April 11th, 2009 at 5:11 pm

Comments (1)

Debt is a another way of life for many fellow American citizens. We owe money on our homes, our cars, our possessions, and our education,yeah even education Many Americans are so mired in debt they aren’t even sure just how much they owe and to whom,even worse they sometimes don’t even remember just what caused their debt.

Some debt is good for you. For example, what you owe on your home can provide a nice way to balance out your income tax. A little debt is not a bad thing either as making regular payments to various creditors helps build your credit rating which makes it easier for you to obtain loans at good rates. However the truth is that most Americans have more than a little debt — and many owe far too much money and are already, or soon will be, in financial trouble as a result.

Finding yourself owing a lot of money is not the end of the road and you can stop your cycle of debt by taking four positive steps to break the cycle.

First, attack your high-cost debts. This likely includes credit cards where you may be paying high minimum payments and high interest rates. Pay off the balances on credit cards carrying the highest interest rates first. Continue making your minimum payments for lower-interest cards but concentrate on paying off the highest interest. When the high-cost cards are paid off then work to eliminate the balances on your other cards.

Second, reach out to your creditors. If you are going to be late or have difficulty paying your minimum payments then contact the credit card company. Even if you can make all your payments in a timely fashion there are two benefits you can reap from contacting the card issuer. First, you may be able to negotiate lower rates or more favorable terms. Second, they might be able to recommend alternatives that can minimize damage to your credit rating.

Third, consolidate your debts as much as possible. You can accomplish this a number of ways. One possibility is simply transferring balances from one credit card to another with a lower rate, but be aware of transfer fees before choosing this option. Another possibility, if you own your own home, is to take out a home-equity loan or line of credit which should have a lower interest rate than most credit cards can offer as well as offering tax deductions. Finally, you can also consider a secured loan offering the value in another form of property, your vehicle for example.

Fourth, don’t sacrifice your retirement savings. Obviously paying off your debt should be a high financial priority but cutting what you save for retirement to do so may not be the wisest course — especially if that becomes a long term habit or if you are losing out on your employer’s matching funds as a result. Perhaps you may be able to borrow against (or from) your retirement funds at a lower interest rate which will allow you to continue to save for retirement while also getting out from under your debt.

While owing money may well be the American way it can also be a tremendous burden to bear. You can shed the weight of your load or at least trim it down to a more manageable level by taking these four steps.

Getting out of debt can be a long, drawn out process. If you spent years wrestling with financial problems, the solution will not come to you overnight. It can take months, even years to unravel debt difficulties but it can be done. You have some options to help you get started; let’s take a look at four of them:

Credit counseling companies are vying for your business. This can be a good option as you shop around to find the best plan out there, but bad as you learn that many companies will charge exorbitant fees or do work for you that you can do yourself. Some government agencies and nonprofit firms provide credit counseling too. For little or no money you may be able to find a professional who can help you navigate through your debt dilemma.

Replace your high interest credit cards with one, low interest rate credit card. You could also see if a lending institution will give you a debt consolidation loan. However, you may have to pay for an application fee, whereas with a credit card you would not.

Even with rising interest rates, refinancing your mortgage may make sense and allow for you to save hundreds of dollars per month on mortgage payments. With the monies saved with a new, lower mortgage payment you could use your savings to pay off your other debt.

Alternately to home refinancing, you may have enough equity in your home to cash out and pay off your debt. Importantly, although credit card debt is not tax deductible, a home equity loan is. Ultimately, you can reduce your debt as well as reduce your tax obligation by cashing out.

You have some viable solutions to help you reduce your debt. Learn all you can about each option and select the plan that is right for you.